Issues related to environmental, social, and governance (ESG) factors have long been on CFOs’ agendas, but a number of developments in the past year have moved them to the forefront.
Jurisdictional policies, supported by several new or proposed requirements on ESG reporting and disclosure are driving this acceleration, creating a range of considerations for CFOs as they determine how best to address this multifaceted and important area. Here are some tips finance leaders can follow to help lead change.
Monitor regulations and standards
“There is momentum among stakeholders, who are demanding and requiring much broader and deeper understanding of a business, more transparency,” said Jason Hamilton, ACMA, CGMA, principal, leveraged finance, at Nedbank in Cape Town. The pressure driving new regulations comes from shareholders and investors as well as financiers, customers, suppliers, and society in general.
Although some ESG requirements may apply only within specific jurisdictions or industries, some will have a global impact. The EU’s Corporate Sustainability Reporting Directive and two new climate change-related laws from the US state of California apply to companies doing business within their jurisdictions (see the sidebars “ESG Requirements: EU” and “ESG Requirements: California, US”).
The initial standards of the IFRS Foundation’s International Sustainability Standards Board (ISSB), however, will have a more global reach (see the sidebar “ESG Requirements: ISSB” below). The US Securities and Exchange Commission’s climate-change rules would also have a significant effect for listed companies in the US. Although the SEC voluntarily stayed implementation of its rules on 4 April, it explicitly notes in the stay order that its 2010 climate guidance is not stayed, and professional advisors are recommending that US companies continue to prepare voluntary climate-related disclosures.
As a result, no matter where a company is based, if it has international interests, it may need to report on ESG from as early as the financial year beginning 1 January 2024.
Whether or not they are immediately affected by the standards, CFOs should be familiar with sustainability-related risks, opportunities, and impacts that have a material financial impact on their organisation and where their organisation has a material environmental and social impact through their operations, value chain, products, or services. Even those that are not subject to the standards will be affected as organisations reach down their supply chain for information on their business partners’ practices.
Failure to understand and comply with applicable mandatory standards could carry significant penalties, noted Rex Gu, FCMA, CGMA, Europe head of finance, Logistics, at Copenhagen-based A.P. Moller – Maersk, one of the world’s largest shipping and logistics companies. “In this sector, adherence to evolving ESG regulations, such as emissions standards for maritime transport, is critical,” he said, adding, “CFOs must ensure compliance and enhance the transparency and quality of ESG reporting.”
Focus on rigorous ESG reporting
Investors will expect the quality of sustainability-related financial data to be on par with that of financial data, said Jeremy Osborn, FCMA, CGMA, CPA (Australia), D.Phil., global head of sustainability at AICPA & CIMA, together as the Association of International Certified Professional Accountants. When new ESG standards call for independent assurance, CFOs signing off on sustainability-related financial data will be responsible for its accuracy and completeness.
In addition, CFOs, who are used to internal controls over financial reporting, will now have to focus on internal controls over sustainability reporting and the sustainability-related financial data involved, according to Ash Noah, CPA, FCMA, CGMA, vice-president and managing director–Learning, Education, and Development at AICPA & CIMA. “Any report on ESG should be based on data and backed up by evidence and [be] defensible,” he said. That may require adding ESG reporting expertise to the finance team and exercising close oversight if drawing on sustainability expertise from external consultants. “Be sure you treat sustainability reporting with the same level of rigour as financial reporting,” he said.
Currently, sustainability information may be managed mainly by the sustainability team, noted Osborn, but he anticipates that the team will collaborate more with finance. And while finance may or may not have ultimate responsibility for collecting the data, it can play an important role in improving ESG data quality, he said.
In companies large and small, the challenge for many CFOs will be to have a clear view of ESG efforts and identify gaps in reporting them. CFOs will need to gauge their organisation’s ability to implement any mandatory standards or meet stakeholders’ reporting expectations, Hamilton said. In addition to assessing capabilities to collect, measure, and report ESG data, leaders will also need to identify current ESG initiatives.
Articulate ROI for ESG efforts
Given the increasing frequency and pace of market change, CFOs should be aware that the ESG ecosystem is developing faster than regulators can react, according to Hamilton. Companies looking to meet carbon reduction and net-zero targets, let alone broader ESG goals, “can’t waste any time waiting for regulators to provide guidance for them”. Instead, companies will need to proactively address and clearly communicate how sustainability-related risks, opportunities, and impacts affect a company’s performance and prospects, cost of capital, and access to capital.
How are companies doing that? At Maersk, a new container ship, the world’s first partly run on methanol, emits 100 tonnes of carbon dioxide less per day than diesel-based ships. The company has already ordered 24 similar ships, and competitors are following suit. As a Maersk CFO, Gu must ensure the investment is worthwhile and provide operating expense calculations for decision-making. This includes deciding if new related costs should be passed on to customers or covered in other ways. Because the ROI for ESG investments may not be immediately clear, CFOs may need to articulate the value of recognising the long-term economic advantages, he said.
Consider social and governance concerns
Although ESG discussions have long focused on environmental concerns and climate change, CFOs should not overlook the social and governance sides addressed by IFRS S1 and S2 and European standards.
In considering social concerns, CFOs will have to ask how the business is affecting communities. The EU ESG standards on social issues provide examples of how CFOs should be looking at these issues, Noah said. They address the treatment of a company’s own workers as well as its impact on workers in its value chain. They also cover the consumer impacts of a company’s products and services. “Organisations better start to understand these dimensions and how they affect the ability to generate future cash flows,” he said. “Anything social presents opportunities or risks, so it has to be on the CFO agenda.”
Governance encompasses numerous issues too, including ethical corporate conduct, board and management skills, experience and diversity, and shareholder rights. Hamilton expects that organisations will need to approach governance more strategically, with a greater focus on effective management and accountability. He sees stakeholders as key to the process. “How we approach and work with them can create strong trust relationships, which ultimately becomes a competitive advantage and supports the core business,” he said.
Opportunity and risk
For many companies, failure to properly address ESG requirements and stakeholder expectations could be an existential issue, Noah said. “Anything, whether an opportunity or risk, that has a material impact on future cash flows must be on the CFO agenda.”
However, with so many new considerations and requirements, it can be hard for CFOs to know where to begin their efforts.
Organisations should begin by determining what changes are immediately necessary. That might mean anything from simple compliance with a narrow segment of standards to changing the company’s business model. CFOs can then take a leadership role in providing the information and insights needed to address each company’s unique ESG risks and opportunities
ESG requirements: ISSB
Standard-setter: The IFRS Foundation’s International Sustainability Standards Board (ISSB).
Standard/law: IFRS S1, General Requirements for Disclosure of Sustainability-Related Financial Information, from the IFRS Foundation’s International Sustainability Standards Board (ISSB), establishes how entities should disclose information about sustainability-related risks and opportunities that the users of general-purpose financial statements can use in decision-making about providing resources to the entity.
The ISSB’s IFRS S2, Climate-Related Disclosures, requires entities to disclose information on climate-related risks and opportunities that users of general-purpose financial statements can rely on in their decision-making.
Applies to: Entities that are required by their jurisdictional regulators to adopt them or that do so voluntarily because of considerations such as the value that reporting provides for the entity or in response to stakeholder demands for more sustainability information.
The International Organization of Securities Commissions, which regulates the world’s securities and futures markets, has endorsed the ISSB standards and called on members to apply them, so they are expected to become mandatory for more entities. Numerous countries are on a path to adopting them. The UK is already considering endorsement and the process for adoption of the ISSB standards and creating the first two UK Sustainability Disclosure Standards. Expected by the end of Q1 2025, the UK’s decision could set a precedent for other G20 countries outside the EU and Commonwealth countries to adopt the ISSB standards, according to Jeremy Osborn, FCMA, CGMA, CPA (Australia), D.Phil., global head of sustainability at AICPA & CIMA.
Effective date: Both standards are effective for annual reporting periods beginning on or after 1 January 2024 (earlier application is permitted as long as both standards are applied together).
Assurance: Jurisdictional regulators will determine whether assurance is required for ISSB disclosures and if this should be limited or reasonable.
ESG requirements: EU
Standard-setter: The European Commission
Standard/law: The European Commission’s Corporate Sustainability Reporting Directive (CSRD) strengthens the rules concerning the social and environmental information that companies within scope need to include within a dedicated section of the management report.
The CSRD introduces an innovative element: a double materiality assessment. Companies are mandated to identify sustainability factors from a financial materiality perspective (ie, the impact of environmental and societal factors on the company’s financial position, performance, and prospects) and also assess impact materiality (ie, the impact of the company on the environment and society).
Companies subject to the CSRD are required to report according to European Sustainability Reporting Standards (ESRS), which are issued by the European Commission under delegated regulation. Twelve ESRS have been issued, including one standard on general principles for sustainability reporting (ESRS 1), one on general disclosure requirements (ESRS 2); and ten more focused on environmental (ESRS E1–E5), social (ESRS S1–S4), and governance (ESRS G1) concerns.
Applies to: See under “Effective Date” for details.
Effective date: Across the EU, large listed companies, large banks, and large insurance organisations with more than 500 employees must report in line with ESRS during the 2024 financial year, with the first sustainability statement published in 2025.
Other large companies that exceed two of three criteria must start reporting in financial year 2025, with the first sustainability statement published in 2026. Those criteria are 250 employees, net revenue of €40 million, and net assets of €20 million.
Listed SMEs must begin reporting in financial year 2026, with their first sustainability statements published in 2027. Listed SMEs can opt out of the reporting requirements for a further two years (under brief explanation in the management report) but must begin reporting by financial year 2028, with the first sustainability statement published in 2029. Separate standards will be adopted specifically for SMEs.
Non-EU companies that generate more than €150 million annually in the EU and that have either a branch with turnover in the EU of more than €40 million or a subsidiary that is a large company or a listed SME in the EU will have to report the group-level sustainability risks, opportunities, and impacts beginning in financial year 2028, with the first sustainability statement published in 2029.
Assurance: Limited assurance is required, with the ambition of moving to reasonable assurance over time. The EU is developing limited assurance standards, which will be issued before 1 October 2026.
ESG requirements: California, US
Standard-setter: State of California, US
Standard/law: The US state of California’s S.B. 253, the Climate Corporate Data Accountability Act, will require companies to annually report their direct (Scope 1), indirect (Scope 2), and value chain (Scope 3) greenhouse gas emissions.
California’s S.B. 261, the Climate- Related Financial Risk Act, will mandate that companies publish a public report by 2026 (and biennially after that) disclosing their climaterelated financial risk, as well as measures taken to reduce and adapt that risk.
Both S.B. 253 and S.B. 261 require the California state board to publish emissions information for all reporting entities on the board’s website.
Applies to: S.B. 253: Public and private US companies doing business in California with annual revenue of more than $1 billion.
S.B. 261: US entities with total annual revenues in excess of $500 million and that do business in California.
They apply to both public and private entities and to foreign public companies with US-based subsidiaries doing business in California.
Under state law, an entity is considered to be doing business in California if it engages in transactions there for financial gain; is organised or commercially domiciled there; or meets certain sales, property, or payroll thresholds there.
Effective date: Entities must begin making disclosures in 2026. Under S.B. 253, Scope 3 emissions reporting would not be required until 2027 on 2026 data.
Assurance: Limited assurance, moving to reasonable assurance, is required for Scope 1 and 2 emissions, with phase-in of potential limited assurance for Scope 3 emissions.
Anita Dennis is a freelance financial writer based in the US. To comment on this article or to suggest an idea for another article, contact Oliver Rowe at Oliver.Rowe@aicpa-cima.com.
AICPA & CIMA RESOURCES
Briefings
Corporate Sustainability Reporting Directive (CSRD) and (ESRS), 4 April 2024
AICPA Summary: California Climate Disclosure Laws S.B. 253 and S.B. 261, 16 October 2023
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